Event details

In the second half of the 16th century, the large nation-wide domestic public debt was created in Castile (exceeded 50% of GDP), as in England or France two centuries later. These impressive numbers were achieved without the efficient centralized administration and the capital markets that supported the fiscal policies of other countries in later centuries. How could this performance be achieved?

As in 18th century England, but at an earlier stage of the development of capital markets, Castile drew its military supremacy from its superior ability to mobilize large resources through borrowing. Compared with other European countries at that time, Philip II faced several challenges: part of his revenues was subject to independent shocks on the mining of silver from the Americas; the majority of expenditures were abroad; capital markets had not yet developed into centralized places with daily trading (as would be seen in Amsterdam or London); and most importantly, the central government had no direct control over a large part of the tax administration, and had to negotiate with the 18 cities that represented the Castilian Parliament (Cortes) and administered the main taxes.

The adjustments to short-term shocks on the budget were first met by short-term loans. As in 18th century England, financial transactions and debt issuances in Castile were managed by bankers who were in the unique position to handle triangular transactions between Castile, Italy and Flanders. Philip II suspended payments on the short-term debt four times. These “defaults” have attracted a large literature, but Spain had not acentralized budget.

The short-term debt could not be credible (and therefore exist) without the possibility of its conversion into long-term debt; the credibility of the long-term debt required funding through credible tax revenues, which, in turn, required the alignment between the debt holders and the people in charge of establishing the taxes that would service that debt; in the historical and political context of Castile, that alignment was achieved by the decentralization of the debt and the taxes through the intermediation of the eighteen cities that were represented in the Cortes; the level of taxes for debt services put a ceiling on the debt service that had to be negotiated by central bargaining in the Cortes; delays in these negotiations blocked the entire system of debt financing and triggered the suspensions of payment on the short-term debt.

The crises were not short-term liquidity crises. In a standard liquidity crisis, the borrower meets the refusal of the lenders to fill a gap in short-term lending. Here, each of the crises was not triggered by such a constraint but by a payment stop of Philip II. Historians have either specialized only on the relations between the Crown and the Cortes, or the relations between the Crown and the bankers. In order to understand the financial crisis is necessary to see the three players at the same time: Crown, Cortes and bankers, especially in the most important crisis of 1575-1577.